Amicus Curiae Brief — Janus v. Am. Fed'n, 138 S. Ct. 54 (2017) (No. 16-1466)

No. 16-1466

IN THE

Supreme Court of the United States

MARK JANUS,

Petitioner,

Vv.

AMERICAN FEDERATION OF STATE, COUNTY

AND MUNICIPAL EMPLOYEES, COUNCIL 31, et ai.,

Respondents.

On Writ of Certiorari

to the United States Court of Appeals

for the Seventh Circuit

BRIEF OF CERTIFIED PUBLIC

ACCOUNTANTS AS AMICI CURIAE

IN SUPPORT OF NEITHER PARTY

VIRGINIA A. SEITZ*

SIDLEY AUSTIN LLP

1501 K Street, N.W.

Washington, D.C. 20005

(202) 736-8000

vseitz@sidley.com

Counsel for Amici Curiae

December 6, 2017 * Counsel of Record

TABLE OF CONTENTS

Page

TABLE OF AUTHORITIES ..................sscccccsseseees ii

INTEREST OF AMICI CURIAE...............0000000000 1

SUMMARY OF ARGUMENT ...................cccceeesees 1

| ________,_ LTT ETS NS oat a TT 3

I. THE INDEPENDENT AUDITOR PRO-

VIDES ASSURANCE THAT THE UN-

ION’S CHARGEABILITY CHARACTERI-

ZATIONS ARE FAIRLY PRESENTED TO

POTENTIAL OBJECTORS ....00.....ccccccccceeeees 3

A. The Court’s Decisions Concerning The

Role Of The Independent Auditor ............ 3

B. Hudson Audits Must Be Conducted In

Accordance With Auditing Standards Set

Forth By The American Institute Of Cer-

tified Public Accountants, As Well As

With Its Code Of Professional Conduct ...

C. The Independent Auditor Does Not Take

The Union’s Chargeability “Characteri-

zation For Granted,” But Evaluates The

Characterization To Assure That It Is

Presented Fairly And Not Materially

PN biiiinssininenensisinsinicinicaleiimpedinsiiaduabiagtinaes 11

D.The Independent Auditor Rigorously

Evaluates And Tests The Expense Allo-

cation For Material Misstatement .......... 16

CT NIURIIIIIND Caciancecsninnntiiecantsasscictidnniatidnaameveninees 21

ao

(i)

ii

TABLE OF AUTHORITIES

CASES Page

Air Line Pilots Ass'n v. Miller, 523 U.S. 866

hice Aa ce ctiicianinhagintttaiaimneadlnsntdialeedicapiatades 15

Chicago Teachers Union, Local No. 1 v.

Hudson, 475 U.S. 292 (1986) ................ passim

Ellis v. Bhd. of Ry., Airline & S.S. Clerks,

ee 14, 19

Ferriso v. NLRB, 125 F.3d 865 (D.C. Cir.

NSPS TYE RCN Pee Cas ra at ene ne 6

Harik v. Cal. Teachers Ass'n, 326 F.3d 1042

Be GE I icisnrncsenieiainideihasimndbiniensiiatrniibestesui 17

Harris v. Quinn, 134 8. Ct. 2618 (2014)....... 4,5

Knox v. SEIU, Local 100, 567 U.S. 298

SITE senteddduliieatedintatenantiiamamhnrnebonsteiis passim

Lehnert v. Ferris Faculty Ass'n, 500 U.S.

Se EIT niicsnesindisistinaeectsidadieaninmnbienindiajiasimibannte 4

Locke v. Karass, 555 U.S. 207 (2009) .......... 12,13

Otto v. Pa. State Educ. Ass'n — NEA, 330

F.3d 125 (3d Cir. 20038) .........cccscccccscesces 4, 16, 17

Prescott v. Cty. of El Dorado, 177 F.3d 1102

(9th Cir. 1999), vacated on other grounds,

528 U.S. 1111, reinstated in relevant part,

204 F.3d 984 (9th Cir. 2000)..................... 16, 17

Robinson v. New Jersey, 806 F.2d 442 (3d

REE eee ete eran Soames 15

Tierney v. City of Toledo, 917 F.2d 927 (6th

I sss dediciteaalelibaniahtiile 13

OTHER AUTHORITIES

AICPA, AICPA Code of Professional Con-

duct (Aug. 31, 2017), https://www.aicpa.

org/research/standards/codeofconduct.

SUIT dustninccninenbticenmincetnnianateanensibensiendabeiaeeans passim

TABLE OF AUTHORITIES — continued

Page

AICPA, Audit and Attest Standards, In-

cluding Clarified Standards, https://www.

aicpa.org/research/standards/auditattest.

html (last visited Dec. 4, 2017).............. passim

INTEREST OF AMICI CURIAE'

Amici curiae are public accounting firms employing

certified public accountants. See Appendix (listing

firms). Each firm specializes in attestation services

for labor unions, including conducting Hudson audits.

See Chicago Teachers Union Local No. 1 v. Hudson,

475 U.S. 292, 307 n.18 (1986). These established

firms have each been in existence for decades and

amongst them have been performing Hudson audits

since this Court’s decision in 1986. Together, the

amici firms have performed hundreds of Hudson au-

dits for local and international unions throughout the

country, including affiliates of respondent here.

Amici have a strong interest in judicial decisions

involving Hudson audits to the extent those decisions

describe and rest on assumptions and potentially

misunderstandings about the role of the independent

auditor on such engagements. The purpose of this

brief is to assist the Court in understanding the role

that an independent auditor plays in performing a

Hudson audit, to inform the Court of the professional

and ethical standards that govern the auditor on such

engagements, and to address how those standards

affect the auditor’s conduct of a Hudson audit.

SUMMARY OF ARGUMENT

In Hudson, this Court held that a public sector un-

ion’s allocation of expenses that may be charged to

' Pursuant to Supreme Court Rule 37, amici curiae state that

no counsel for any party authored this brief in whole or in part,

and that no entity or person other than amici curiae and their

counsel made any monetary contribution toward the preparation

and submission of this brief. All parties filed blanket consents

with this Court.

2

objecting nonmembers requires “verification by an

independent auditor.” Jd. at 307 n.18. In Knox v.

SEIU, Local 100, 567 U.S. 298 (2012), the Court stat-

ed that in assessing whether a particular expense is

chargeable, the “auditors take the union’s characteri-

zation for granted” and merely perform the “simple

accounting function” of ensuring that the union-

claimed expenditures were actually made for the

claimed expense. /d. at 318-19. The Court wrote

that if a union “believes that supporting sympathetic

political candidates is chargeable and bases its classi-

fication on that view — the auditors will classify these

political expenditures as chargeable.” Id. at 319.

As explained in detail below, however, the ethical

and professional standards that govern independent

auditors do not permit them to take the union’s

chargeability characterizations “for granted.” The

amici accounting firms are governed by a Code of

Conduct and Auditing Standards established by the

America Institute of Certified Public Accountants.

The Code and Standards require the auditor to pro-

vide assurance that the union’s chargeability charac-

terizations are fairly presented to a potential objec-

tor, and to question the union when those characteri-

zations are materially misstated or contrary to set-

tled law. Put differently, if a union were to misclassi-

fy expenses under settled law or to fail to

acknowledge a questionable chargeability classifica-

tion, the auditor would not be permitted to passively

accept those characterizations. For example, were a

union to attempt to classify political expenses as

chargeable, the auditor, absent a union correction,

would either issue a modified opinion or withdraw

from the audit engagement. An auditor would not

3

issue a “clean” or unmodified opinion in this situa-

tion.?

Moreover, the independent auditor's role involves

substantive analytical procedures and testing of the

union’s expenses to confirm not only that union-

claimed expenditures were actually made for the spe-

cific claimed expenses, but further that the allocation

of those expenses to the chargeable or nonchargeable

category is fairly presented. In other words, the au-

ditor reviews and verifies the union’s chargeable and

nonchargeable characterizations based on the aud’

tor’s knowledge of the settled lines that the Court and

others have drawn in this area in order to provide as-

surance that the statements are fairly presented for

all users, including potential objectors.

ARGUMENT

I. THE INDEPENDENT AUDITOR PROVIDES

ASSURANCE THAT THE UNION’S CHARGE-

ABILITY CHARACTERIZATIONS ARE FAIR-

LY PRESENTED TO POTENTIAL OBJEC-

TORS

A. The Court’s Decisions Concerning The

Role Of The Independent Auditor

In Hudson, this Court held that public sector un-

ions must adopt “[pjrocedural safeguards” to ensure

that objecting nonmembers are assessed only the fair-

share fees properly chargeable to them. 475 U.S. at

2 An auditor’s unmodified opinion is one that concludes that

the client’s financial statements are presented fairly in al] mate-

rial respects. A “modified” opinion is one that concludes that the

finar cia] statements are materially misstated or that the audi-

tor is unable to obtain sufficient evidence to conclude that the

financial statements are free from material misstatement. See

infra pp. 9-11, 13-15.

4

302-03. The union must provide the nonmember with

“sufficient information to gauge the propriety of the

union’s fee” so that the nonmember has a basis to de-

termine whether to object to paying the full fee or to

challenge a fair-share fee calculation. Jd. at 306.

Among other “[pjrocedural safeguards,” this Court

held that adequate disclosure requires “verification

by an independent auditor.” Jd. at 307 n.18. The

“purpose of requiring the verification” is to give the

“nonmembers some prior assurance that the . . . fee

was properly calculated”; and when “nonmembers do

not receive that assurance, their constitutional rights

are violated” under Hudson. Otto v. Pa. State Educ.

Ass'n — NEA, 330 F.3d 125, 131 (3d Cir. 2003) (quot-

ing Hohe v. Casey, 956 F.2d 399, 415 (3d Cir. 1992)).

In Lehnert v. Ferris Faculty Association, 500 US.

507 (1991), the Court held that chargeab’ activities

are those (1) germane to collective-bargaining activi-

ty, (2) justified by the government’s vital policy inter-

est in labor peace and avoiding free-riders, and (3)

not significantly adding to the burdening of free

speech.’ Jd. at 519. More than two decades later, in

Knox and Harris v. Quinn, 134 S. Ct. 2618 (2014), the

Court stated that because “of the open-ended nature

of the Lehnert test, classifying particular categories of

expenses may not be straightforward.” Harris, 134 S.

Ct. at 2633; see also Knox, 567 U.S. at 318-19.

Relevant here, the Court wrote that determining

the chargeable “breakdown is problematic” in part

because “auditors typically do not make a legal de-

termination as to whether particular expenses are

3 In general, chargeable expenses include those undertaken to

advance the representational interests of the collective bargain-

ing unit as a whole whereas nonchargeable expenses are those

for political or ideological projects. E.g., Knox, 567 U.S. at 303.

5

chargeable.” Knox, 567 U.S. at 318. Specifically, the

Court expressed its belief that “auditors take the un-

ion’s characterization for granted” and merely per-

form the “simple accounting function” of ensuring

that the union-claimed expenditures were actually

made for the claimed expense. Jd. at 318-19; see Har-

ris, 134 S. Ct. at 2633 (“auditors do not themselves

review the correctness of a union’s categorization”).

The Court continued, “if a union takes a very broad

view of what is chargeable — if, for example, it be-

lieves that supporting sympathetic political candi-

dates is chargeable and bases its classification on

that view — the auditors will classify these political

expenditures as chargeable.” Knox, 567 U.S. at 319.

Respectfully, as we explain below, these statements

rest on a misunderstanding of the independent audi-

tor’s role in a Hudson audit.

B. Hudson Audits Must Be Conducted In Ac-

cordance With Auditing Standards Set

Forth By The American Institute Of Cer-

tified Public Accountants, As Well As

With Its Code Of Professional Conduct

Certified public accountants (“CPAs”) are licensed

by the state or states in which they practice, and are

bound by the Code of Professional Conduct (“Code”)

issued by the American Institute of Certified Public

Accountants (“AICPA”). The AICPA also issues Au-

diting Standards (denominated “AU-Cs” or “Auditing

Standards”) that similarly govern the conduct of

CPAs who perform audits.‘ All audits, including

*The Code and Auditing Standards can be located on the

AICPA’s website. See https://www.aicpa.org/research/standards/

codeofconduct.htm! (Aug. 31, 2917); https://www.aicpa.org/

research/standards/auditattest.htm! (last visited Dec. 4, 2017).

AU-C stands for Clarified Auditing Standard.

6

Hudson audits, must be conducted in compliance

with the generally accepted auditing standards in the

United States (“GAAS”), as specified in the AU-Cs.

See Ferriso v. NLRB, 125 F.3d 865, 871 (D.C. Cir.

1997) (“Federal and state authorities and professional

associations have devoted considerable effort to de-

veloping standards of independence and professional-

ism for audits of businesses, employee benefit plans,

and the like; potential objectors to agency fees should

not be required to rely on an audit that does not meet

the prevailing standards for audits ....”).

CPAs take seriously their duty to comply with the

Code and Standards. Violations of either could sub-

ject the CPA andor his or her firm to sanctions by, or

expulsion from, the AICPA, monetary sanctions from

the CPA’s State Board of Accountancy, or in extreme

circumstances the loss of the CPA's license to practice

public accountancy. Compliance with the Code and

Standards, in other words, is of the utmost im-

portance to CPAs.

The Code. The Code broadly defines the profes-

sional and ethical obligations of CPAs in all aspects of

the accounting profession. It recognizes that as pro-

fessionals, CPAs “should exercise sensitive profes-

sional and moral judgments in all their activities.”

Code § 0.300.020.01. It obligates them to “serve the

public interest” and “to honor public trust,” noting

that a “distinguishing mark” of CPAs is their “re-

sponsibility to the public.” Jd. §§ 0.300.030.01,

0.300.030.02. The “public” extends far beyond the

CPA’s client — it includes all “others who rely on the

objectivity and integrity of members to maintain the

orderly functioning of commerce.” Id. § 0.300.030.02.

CPAs must act with the “highest sense of integrity,”

id. § 0.300.040.01, which requires them to “observe

both the form and the spirit of technical and ethical

7

standards; circumvention of those standards consti-

tutes subordination of judgment.” Jd. § 0.300.040.04.

They also must “maintain objectivity and be free of

conflicts of interest” and should be “independent in

fact and appearance when” conducting an audit. /d.

§ 0.300.050.01. This objectivity requirement “impos-

es the obligation to be impartial, intellectually hon-

est, and free of conflicts.” Id. § 0.300.050.02.

CPAs must exercise due care, meaning they are re-

quired to “observe the profession’s technical and ethi-

cal standards, strive continually to improve compe-

tence and the quality of services, and discharge pro-

fessional responsibility to the best of [their] ability.”

Id. § 0.300.060.01. In other words, they must be

competent and diligent and have “mastery of the

common body of knowledge” required for their work.

Id. § 0.300.060.03.

The Auditing Standards. The Auditing Stand-

ards universally apply when a CPA is conducting an

audit, including a Hudson audit. Those Standards

provide that the “purpose of an audit is to provide fi-

nancial statement users with an opinion by an audi-

tor on whether the financial statements are presented

fairly, in all material respects, in accordance with an

applicable financial reporting framework, which en-

hances the degree of confidence that intended users

can place in the financial statements.” AU-C § 200.04

(emphasis added); id. §§ 200.12; 200.A1. The auditor

must “obtain reasonable assurance abou’ whether the

financial statements as a whole are free from materi-

al misstatement, whether due to fraud or error.” Id.

§ 200.06. Misstatements are material if “they could

reasonably be expected to influence the economic deci-

sions of users that are taken based on the financial

statements.” Jd. § 200.07 (emphasis added); see id.

§ 320.02 (same).

8

A material misstatement may exist for the overall

financial statement or for “classes of transactions, ac-

count balances and disclosures.” Jd. § 200.A38.

Moreover, a misstatement may result from fraud or

error, including from “judgments of management con-

cerning accounting estimates that the auditor consid-

ers unreasonable or the selection or application of ac-

counting policies that the auditor considers inappro-

priate.” Id. § 450.A1(e).

GAAS require that auditors “exercise professional

judgment and maintain professional skepticism

throughout the planning and performance of the au-

dit,” including based “on an understanding of the en-

tity and its environment, including the entity’s inter-

nal control{s].” Jd. § 200.08; see also id. §§ 200.15,

200.17, 200.18. Exercising professional judgment

means “application of relevant training, knowledge,

and experience, within the context provided by audit-

ing, accounting, and ethical standards, in making in-

formed decisions about the courses of action that are

appropriate in the circumstances of an audit engage-

ment.” Jd. § 200.14. Professional skepticism means

an “attitude that includes a questioning mind, being

alert to conditions that may indicate possible mis-

statement due to fraud or error, and a critical as-

sessment of audit evidence.” Id.

Auditors must also act in the “public interest” and

“be independent of the entity subject to the audit.”

Id. § 200.A17. The independence must be in both

“fact” and “appearance.” Id.

Critically here, the auditor’s opinion will also “de-

pend upon the applicable financial reporting frame-

work and any applicable law or regulation.” /d.

§ 200.09; see id. §§ 200.A3, 800.07e (“logical, reasona-

ble criteria” applicable to items reviewed in a Hudson

audit). This includes the “legal and ethical environ-

9

ment, including statutes, regulations, [and] court de-

cisions,” as well as general and “industry practices

widely recognized and prevalent.” Jd. § 200.A6. See

also id. § 250.04 (auditor responsible for “identifying

material misstatement ... due to non-compliance

with laws”).

When the auditor identifies a misstatement, the

auditor will communicate it to the client and request

that the client “correct” the misstatement. AU-C

§ 450.07. If the client “refuses to correct” some or all

of the misstatement, the auditor should understand

the reasons for not making the correction and take

those reasons “into account when evaluating whether

the financial statements as a whole are free from ma-

terial misstatement.” Jd. § 450.09. In determining

whether the uncorrected misstatement is material,

the auditor shall make such determination “based on

the auditor’s understanding of the user needs and ex-

pectations,” including potential objectors in the Hud-

son audit context. Jd. § 450.A18 (emphasis added);

see infra p. 11 (citing Code § 0.300.030.02).

If the auditor determines that it cannot offer rea-

sonable assurance that the financial statements are

free from material misstatement, the auditor must

either issue a modified opinion or withdraw from the

engagement (where possible). See id. §§ 200.13,

705.02, 705.05, 705.07(b).5 If the auditor does not

5In amicis experience, an auditing firm’s standard engage-

ment letter will warn the client about the possibility of a modi-

fied opinion by stating, for example: “We cannot provide assur-

ance that an unmodified opinion will be expressed. Circum-

stances may arise in which it is necessary for us to modify our

opinion or add an emphasis-of-matter or other-matter para-

graph. If our opinion is other than unmodified, we will discuss

the reasons with you in advance. If, for any reason, we are una-

ble to complete the audit or are unable to form or have not

10

withdraw from the engagement but instead issues a

modified opinion, it will be either a qualified opinion,

an adverse opinion, or a disclaimer of opinion. Id.

§§ 705.02, 705.05, 705.07(b). The auditor should is-

sue a “qualified opinion” where there is sufficient ap-

propriate audit evidence,® and the misstatements are

“material but not pervasive,” id. § 705.08(a), and an

“adverse opinion” where the misstatements are “ma-

terial and pervasive.” Jd. § 705.09. The auditor

should disclaim an opinion where there is not suffi-

cient audit evidence on which to base an opinion and

the auditor concludes that the possible effects of un-

detected misstatements could be both material and

pervasive. Jd. §§ 705.10, 705.13. When an auditor

issues a modified opinion, it should “include a para-

graph in the... report that provides a description of

the matter giving rise to the modification.” Id.

§ 705.17.

Moreover, even if the opinion is unmodified, an au-

ditor retains discretion to insert an “emphasis-of-

matter” or “other-matter” paragraph. Jd. § 706. An

auditor may insert such a paragraph when it is “nec-

essary,” in the auditor’s professional judgment, to

bring to the user’s attention a matter of “such im-

portance that it is fundamental to the users’ under-

standing of the financial statements,” or “relevant to

the users’ understanding of the audit, the auditor’s

responsibilities, or the auditor’s report.” Id. § 706.04.

formed an opinion, we may decline to express an opinion or

withdraw from this engagement.”

6 “Audit evidence” is defined as “[i]nformation used by the au-

ditor in arriving at the conclusions on which the auditor’s opin-

ion is based. Audit evidence includes both information con-

tained in the accounting records underlying the financia! state-

ments and other information.” AU-C § 500.05.

11

C. The Independent Auditor Does Not Take

The Union’s Chargeability “Characteriza-

tion For Granted,” But Evaluates The

Characterization To Assure That It Is

Presented Fairly And Not Materially Mis-

stated

Independent auditors conducting a Hudson audit of

a union have two audiences: the union’s governing

body, and potential objectors and/or challengers. See,

e.g., Code § 0.300.030.02 (auditor must serve all “oth-

ers” who rely on the objectivity and integrity of the

audit). The very purpose of the audit is to ensure

that “potential objectors be given sufficient infor-

mation to gauge the propriety of the union’s fee” and

thus to determine whether to object or to challenge

the union’s calculation of the reduced fair share fee.

Hudson, 475 U.S. at 306.

With that latter user in mind, the auditor has a du-

ty to offer assurance that the union’s allocations of

chargeable expenses and nonchargeable expenses are

“presented fairly” and without “material misstate-

ment.” AU-C § 200.04, 200.06. The potential objector

must be provided with an appropriate “degree of con-

fidence” in the statements. Jd. § 200.04. And, alt-

hough classification of a particular expense as

chargeable is a legal determination, the auditors who

perform these audits are fully versed in the legal re-

quirements of Hudson and its progeny, and they re-

view those classifications (and underlying definitions)

with professional skepticism in light of “any applica-

ble law,” including “court decisions” and “industry

practices.” See id. §§ 200.09, 200.A6; see also id.

§ 250.A5 (while noncompliance of law is a matter for

legal determination, “the auditor’s training, experi-

ence and understanding of the entity and its industry

or sector may provide a basis to recognize that some

12

acts coming to the auditor’s attention may constitute

noncompliance with laws”).

Auditors thus do not — and indeed, may not — take

the union’s chargeability characterizations “for

granted.” Knox, 567 U.S. at 318. Instead, they sub-

ject them to scrutiny to verify that the statement as a

whole is fairly presented to the potential objectors or

challengers. For example, if a union “believes that

supporting sympathetic political candidates is

chargeable and bases its classification on that view,”

the auditor most certainly will not “classify these po-

litical expenditures as chargeable.” Jd. at 319. In-

stead, because of their training, expertise, and

knowledge of the “applicable law” and “court deci-

sions” about Hudson chargeability issues, see AU-C

§§ 200.09; 200.A6, the auditors would not accept such

a classification, which is contrary to settled law. E.g.,

Locke v. Karass, 555 U.S. 207, 210 (2009) (“political

expenditures” are not chargeable); see supra pp. 8-9.

Such a classification would constitute a material mis-

statement resulting in an unfair presentation to po-

tential objectors.’ A CPA confronting such a situa-

tion and determining whether to issue an unqualified

opinion would be required by governing professional

standards to ask: “Am I doing what a person of integ-

rity would do? Have I retained my integrity” Code

§ 0.300.040.04. The answer would be “no.”

In such a circumstance, the auditor would confer

with union management and/or legal counsel and re-

quest that the union correct the misstatement. AU-C

§ 450.07. In amici’s experience, an auditor in that

7 It would be akin to a umion’s attempting to classify legal bills

as “rent” by stating in a definition that “legal bills shall consti-

tute rent.” Plainly, an auditor would not accept such a mischar-

acterization.

13

situation would emphasize that a failure to correct

will result in a modified opinion or withdrawal from

the engagement. And, again in the experience of

amici, when faced with these possible consequences,

unions are responsive to the auditor’s criticisms and

agree to the correction. If the union does not agree,

however, the auditor will either issue a modified

opinion to make the disagreement clear, or withdraw

from the engagement if the modification is deemed

insufficient. Jd. §§ 200.13, 705.05. Issuing an un-

modified opinion in such a circumstance would be

contrary to the Code and standards described above.

Thus, while auditors do not have authority to make a

binding legal determination or otherwise to compel a

union to change its classifications of expenses, they

may not issue an unmodified opinion on a Hudson

audit that is inconsistent with settled law.®

Even in areas of unsettled law, the auditor would

take action if it were to discover during the course of

the audit that the union is making a potentially ques-

tionable chargeability classification. For example,

litigation expenses incidental to the union’s negotia-

tion or administration of the collective bargaining

agreement or other litigation normally conducted by

an exclusive representative are chargeable, whereas

litigation expenses lacking such a connection to col-

lective bargaining are not chargeable. See Locke, 555

8 Although the chargeability decision itself is a legal determi-

nation, Tierney v. City of Toledo, 917 F.2d 927, 936 n.7 (6th Cir.

1990), auditors must follow their professional standards and

ensure that union chargeability definitions and classifications

are presented fairly to potential objectors in accordance with

governing law. See supra pp. 8-9. Moreover, auditors are aware

that they may be called as witnesses, whether at an arbitration,

in court, or at a state labor board, and thus must be able to ex-

plain under oath to an impartial decision maker why the opinion

is defensible. See Hudson, 475 U.S. at 307.

14

U.S. at 215; Ellis v. Bhd. of Ry., Airline & S.S. Clerks,

466 U.S. 435, 453 (1984) (holding non-chargeable liti-

gation expenses related to protecting the rights of

employees generally during bankruptcy proceedings

as too attenuated from collective bargaining). If a un-

ion were to attempt to take a questionable position

and define as chargeable a litigation with only an at-

tenuated relationship to collective bargaining, the

auditor would not merely “take the union’s character-

ization for granted.” Knox, 567 U.S. at 318. Rather,

after questioning the union about the basis for and

reasonableness of the classification, the auditor

would ensure that the user — the potential objector —

understands the union’s position and the unsettled

nature of the question, so that he or she can make an

informed decision about whether to challenge the

classification.

For example, in such a situation the auditor could

issue a qualified opinion in which the auditor opines

that the Hudson statements are presented fairly in

all material respects except for the one particular

classification decision. AU-C §§ 705.08, 705.17,

705.18. The auditor would then include a paragraph

describing for the user the basis of the reasons for the

modified opinion and explaining why the particular

classification decision is not presented fairly to per-

mit the objector to understand the nature of the posi-

tion. Id. § 705.17.

Alternatively, the auditor may conclude that the

classification position does not rise to the level of a

materiai misstatement, but is nevertheless “funda-

mental to [the potential objector’s] understanding of

the financial statements.” Jd. § 706.01. In this situa-

tion, the auditor would either require that the defini-

tional notes to the Hudson financial statements be

made explicit in describing the expense as a chargea-

15

ble one, or would insert an “emphasis-of-matter” par-

agraph in the opinion letter explaining the unsettled

nature of the position. Jd. In these circumstances,

the auditor would provide an unmodified opinion, hut

would nevertheless draw the attention of the p .en-

tial objector to the relevant classification decision. It

would describe both the classification and the audi-

tor’s position on the classification in detail. In this

manner, it would permit the potential objector to

make an informed decision with “sufficient infor-

mation” about whether to challenge the classification

before an impartial decision maker, be it an arbitra-

tor, a state labor board, or a court. Hudson, 475 U.S.

at 307; see Airline Pilots Ass’n v. Miller, 523 U.S. 866,

877-78 (1998) (objectors need not exhaust union pro-

cedures and may proceed directly to court); Robinson

v. New Jersey, 806 F.2d 442, 450 (3d Cir. 1986) (chal-

lenging classifications before a state labor board).®

In sum, the independent auditor has a professional

obligation to assure that the Hudson statement is

“presented fairly” in all material respects to a poten-

tial objector. If a union were to take the position that

political expenditures were chargeable or some simi-

larly questionable classification position, the auditor

would not simply issue an unmodified opinion. Ra-

ther, the auditor would request that the union correct

the misstatement, and, absent a correction, would

take steps to ensure that a potential objector would

become aware of an aggressive position, whether

through a modified opinion, expanded disclosure in

the notes to the financial statements, or an “empha-

sis-of-matter” paragraph. If, due to the significance

of the positions in question, the auditor deemed the

® By challenging the classification before a court or state labor

board, the challenger may transform an unsettled area of law

with respect to chargeability into a settled area of law.

16

modifications to the opinion or financial statement

insufficient, the auditor would withdraw from the en-

gagement.

D. The Independent Auditor Rigorously

Evaluates And Tests The Expense Alloca-

tion For Material Misstatement

The independent auditor does not perform a rote,

unquestioning, “simple accounting function” on a

Hudson audit. See Knox, 567 U.S. at 318. Instead,

the independent auditor plays a significant role in as-

suring not only the accuracy of the union’s expenses,

but also their allocation to chargeable and non-

chargeable categories. The audit firm must do so in

order to comply with its professional obligations and

to ensure that the Hudson statements are fairly pre-

sented to potential objectors or challengers. We set

forth below the steps an independent auditor takes

with respect to a Hudson audit.

As a preliminary matter, an auditor can provide

three levels of verification with respect to financial

statements: a compilation, a review, or an audit. A

compilation involves preparing a financial statement

in which the auditor expresses “no assurance of accu-

racy, completeness or conformity with generally ac-

cepted accounting principles.” Prescott v. Cty. of El

Dorado, 177 F.3d 1102, 1106 (9th Cir. 1999), vacated

on other grounds, 528 U.S. 1111, reinstated in rele-

vant part, 204 F.3d 984 (9th Cir. 2000). An account-

ant performing a compilation need not “verify or cor-

roborate” the financial statement information. Otto,

330 F.3d at 133.

A review involves an intermediate level of scrutiny

and results in an expression of only “limited assur-

ance” because the auditor relies on representations of

management that there are no material modifications

17

that need to be made. Prescott, 177 F.3d at 1106-07;

Otto, 330 F.3d at 133. In conducting a review, the

auditor makes a limited, not a comprehensive, “in-

quiry into client management, accounting practices,

internal control structure, and analytical proce-

dures.” Otto, 330 F.3d at 133.

By contrast, an audit “consists of sufficient inde-

pendent examination to express an opinion on the

fairness, in all material respects, of the financial

statement.” Prescott, 177 F.3d at 1107. It provides

the “highest level of assurance on financial state-

ments,” and “provides verification of the financial

statements’ claims and assertions.” Otto, 330 F.3d at

133. It requires “the accountant to assess the organi-

zation’s internal control procedures” and “examine

evidence supporting the amounts in the financial

statement using an appropriate sampling frequency.”

Prescott, 177 F.3d at 1107.

The courts of appeals that have directly confronted

the issue have held that only a “true audit” meets the

verification requirement of Hudson. Prescott, 177

F.3d at 1108; see also Otto, 330 F.3d at 134 (“local un-

ions, regardless of their size, are required to obtain

audits of their financial statements”). And, in amici’s

experience, they perform audits to verify the alloca-

tion of expenses by public sector unions.'° Prescott,

177 F.3d at 1107. An audit is the highest level of ver-

ification that auditors can provide.

Moreover, the independent auditor’s verification is

substantive, extensive, and complex. A Hudson audit

‘© The Ninth Circuit has he!d that there is a limited exception

to the true audit requirement for smal! local unions with under

$50,000 in estimated revenue. Harik v. Cal. Teachers Ass'n, 326

F.3d 1042, 1047 (9th Cir. 2003). The Third Circuit has rejected

this position. Otto, 330 F.3d at 132.

18

engagement begins with the planning process. See

AU-C § 300. During planning, the independent audi-

tors perform preliminary analytical procedures,'! see

id. § 520 (describing analytical procedures in detail),

to determine what further testing will be done during

the engagement, assess risks, and formulate an audit

strategy. By way of example, this may entail examin-

ing each line item of expenditures from the prior year

and comparing the expenditures in the current year

to what the auditor, based on the auditor’s knowledge

of the union and its environment, id. § 315, expected

the expenditures to be. In 2016, a Presidential elec-

tion year, for instance, the auditor would expect the

amount of political expenditures to have increased. If

they had not, the auditor would mark for increased

testing and analysis expenditures in the political

realm.

The auditor that performs the union’s Hudson au-

dit is also often the same auditor that audited the un-

ion’s basic financial statements (which, when pre-

pared in accordance with GAAS, reflect the financial

position, results of operations, and cash flows for the

year). Those financials, too, would have been sub-

jected to testing, including on the internal controls of

the union concerning, for example, cash disburse-

ments, payroll, and employee benefits. The auditor

thus is generally able to use its knowledge of the un-

ion’s operation and the nature of its expenses,

learned during the audit of the financial statements,

u Analytical procedures are “[e]valuations of financial infor-

compass such investigation, as is necessary, of identified fluctu-

ations or relationships that are inconsistent with other relevant

information or that differ from expected values by a significant

amount.” AU-C § 520.04.

19

to aid in the evaluation of the reasonableness of the

union’s definitions and methodologies in its Hudson

allocations.

The next step is for the independent auditor to re-

quest supporting documentation of relevant expenses

for the year on a sample basis. See AU-C § 530. The

auditor will request supporting documentation for a

subset of items that are considered necessary to test

based on the preliminary analytical procedures de-

scribed above. The auditor then would spend signifi-

cant time reviewing documentation of the expenses,

confirming not only that the union made the expendi-

tures claimed, but also that the allocation between

chargeable and nonchargeable expenses has been

made in accordance with the definitions and method-

ologies outlined in the notes to the Hudson state-

ments, and, as discussed in Part 1.C, ensuring that

the definitions and methodologies are reasonable and

in accordance with the law.

For example, the printing and distribution costs of

a union publication such as its newsletter are

chargeable to the extent the articles in the publica-

tion concern chargeable activity. Eilis, 466 U.S. at

451. Allocation of expenses in this setting is typically

done on the basis of the square inches of the publica-

tion devoted to chargeable versus nonchargeable ac-

tivity. The auditor will not only re-measure the arti-

cles to ensure that the union’s measurements result-

ing in the allocation percentage are accurate, but will

also review each article to verify that the content of

the article itself is properly characterized as chargea-

ble or nonchargeable. If the union attempted to clas-

sify an article taking a position on the preferred can-

didate in a gubernatorial election, for instance, as

chargeable, the auditor not would simply accept that

characterization, but would instead ask the union to

20

correct the allocation and treat the article as non-

chargeable.

As another example, with respect to union meetings

or conferences, the auditor reviews the agenda of the

meeting or the minutes of the meeting to verify the

percentage of the meeting spent on chargeable versus

nonchargeable activities. !”

Once the auditor concludes the testing, the audit

evidence gathered and tested goes through a multi-

level quality control review process within the audit

firm. Various levels of internal staff (such as a field

supervisor, a partner in charge, and quality control

partner) review the audit to assure that the auditor

has conducted procedures sufficient to verify the

Hudson statements. Moreover, every three years the

audit firm is itself subject to a peer review by an in-

dependent qualified third-party accounting firm. The

peer reviewer analyzes the audit firm’s accounting

and auditing process, and it may select for review any

Hudson audit conducted in the time period subject to

review. The AICPA established the peer review pro-

gram almost forty years ago, and participation is re-

quired for all AICPA member firms with an account-

ing and auditing practice.

Finally, once the auditor has performed all neces-

sary procedures and tests on a sufficient and appro-

priate amount of audit evidence, the auditor will is-

sue an opinion on the Hudson statements. The audi-

tor will issue an unmodified opinion only if the audi-

tor determines that the statements are presented

fairly, in all material respects, including for the actu-

al expenses of the union and the allocation of those

‘2 Other tests performed include review and verification of

employee salaries, review of employee time and activities, and

review of travel expenses and the purpose of those expenses.

21

expenses between chargeable and nonchargeable on

the basis of the definitions and significant factors and

assumptions in the statements.

CONCLUSION

For the foregoing reasons, amici respectfully re-

quest that this Court rest its judgment on a complete

and accurate understanding of the role and work of

an independent auditor conducting a Hudson audit.

Respectfully submitted,

VIRGINIA A, SEITZ*

SIDLEY AUSTIN LLP

1501 K Street, N.W.

Washington, D.C. 20005

(202) 736-8000

vseitz@sidley.com

Counsel for Amici Curiae

December 6, 2017 * Counsel of Record

APPENDIX

LIST OF AMICI CURIAE

Buchbinder Tunick & Company LLP

Calibre CPA Group PLLC

Legacy Professionals LLP

Lindquist LLP

Novak Francella LLC, CPAs

WithumSmith+Brown, PC